Chapter 18

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Yorkville University *

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3243

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Accounting

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Jan 9, 2024

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Chapter 18 Question 1 Assume that BT Corporation reports accounting income of $200,000 in each of the years 2020, 2021, and 2022 and has multiple differences between accounting income and taxable income. Assume also that the company is subject to a 30% tax rate in each year, and has the following differences between income reported on the financial statements and taxable income: • Revenue of $18,000 is recognized in 2020 for financial reporting purposes. The customer pays $1,000 per month starting Jan 1, 2021. • Warranty worth $30,000 was provided on sales and recognized as expense in 2020. Actual warranty work was $20,000 in 2021 and $10,000 in 2022 • A premium of $5,000 is paid in each of 2021 and 2022 for life insurance on key officers. • Required: 1. Which of the items listed are temporary and which are permanent differences for BT Corp.? Revenue of $18,000 is recognized in 2020 for financial reporting purposes. The customer pays $1,000 per month starting Jan 1, 2021. Temporary difference, 2020  recorded as Revenue accounting income, CRA  it will be revenue. 2021  12,000 is taxed (taxed as $$ received) 2022  6,000 is taxed (taxed as $$ received) Warranty worth $30,000 was provided on sales and recognized as expense in 2020. Actual warranty work was $20,000 in 2021 and $10,000 in 2022 Temporary difference, 2020  Recorded for accounting purpose  30,000 expense CRA 2021  $20,000 recorded as service is performed. 2022  $10,000 recorded as service is performed A premium of $5,000 is paid in each of 2021 and 2022 for life insurance on key officers 1

2. Provide a reconciliation of BT's accounting income to its taxable income for each of 2020, 2021, and 2022 2020 2021 2022 Accounting Income Adjustments: (CRA rules) $200,000 $200,000 $200,000 Revenue Temporary difference Differed tax liability (18,000) Origin $12,000 $6,000 Warranty Expense Temporary difference Differed tax asset +30,000 Expenses are deducted from the accounting income, so add it back since there were no claims in 2020 Origin (20,000) (10,000) Insurance expense Permanent difference 5,000 5,000 Taxable Income 212,000 197,000 201,000 Temporary difference, can be recorded as 1) Differed tax liability  lead to more taxes to be paid in future. a. if the revered is (+), then differed tax liability. b. When revered, more cash/revenue, meaning more taxes. 2) Deferred Tax asset  lead to tax saving in future, a. If the revered is (-), then differed tax asset. b. When revered, less cash/revenue, meaning less taxes. Differed meaning that it is taxed in the future, not right now. 3. Record the journal entries related to taxes on Dec.31, 2020, using  Taxes payable Method  Acceptable under only ASPE  Record current income tax expense & ignore the temporary diff (deferred tax) 2 Reverse Reverse Reverse

2020 2021 2022 Accounting income adjustment: 200,000 200,000 200,000 Revenue (18,000) Origin 12,000 Reversed 6,000 Reversed Warranty 30,000 Origin (20,000) Reversed (10,000) Reversed Insurance Premium 5,000 5,000 Taxable Income 212,000 197,000 201,000 Dr. Current income tax expense 63,600 (212,000 * 0.30) Cr. Income tax payable 63,600  Temporary difference approach (ASPE & IFRS)  Accepted method for IFRS, and choice for ASPE  Two entries are required  Current income tax  Deferred tax ( temporary diff) 2020 2021 2022 Accounting income adjustment: 200,000 200,000 200,000 Revenue (18,000) Origin 12,000 Reversed 6,000 Reversed Warranty 30,000 Origin (20,000) Reversed (10,000) Reversed Insurance Premium 5,000 5,000 Taxable Income 212,000 197,000 201,000 1) Dr. Current income tax expense 63,600 (212,000 * 0.30) Cr. Income tax payable 63,600 2) Record deferred tax asset a. You must classify temp diff in the year of origin as deferred tax asset/ liability 2020 ( origin) Deferred tax liability (18,000) Deferred tax asset 30,000 Deferred tax asset 12,000 ( 12,000*0.30) = 3,600 Dr. Deferred tax asset 3,600 Cr. Deferred income tax benefit 3,600 4. Prepare related journal entries for 2021 and 2022 3

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Dec 31, 2021 2020 2021 2022 Accounting income adjustment: 200,000 200,000 200,000 Revenue (18,000) Origin 12,000 Reversed 6,000 Reversed Warranty 30,000 Origin (20,000) Reversed (10,000) Reversed Insurance Premium 5,000 5,000 Taxable Income 212,000 197,000 201,000 1) Dr. Current income tax expense 59,100 (197000 * 0.30) Cr. Income tax payable 59,100 2) Reverse ( Decrease) the temp. that was originated in 2020 Deferred Tax asset $2,400 (20,000 – 12,000) = 8000* 0.30 Dr. Deferred Tax Expense 2,400 Cr. Deferred tax assets 2400 Dec 31, 2022 2020 2021 2022 Accounting income adjustment: 200,000 200,000 200,000 Revenue (18,000) Origin 12,000 Reversed 6,000 Reversed Warranty 30,000 Origin (20,000) Reversed (10,000) Reversed Insurance Premium 5,000 5,000 Taxable Income 212,000 197,000 201,000 1) Dr. Current income tax expense 60,300 (201000*0.30) Cr. Income tax payable 60,300 2) Reverse ( Decrease) the temp. that was originated in 2020 Deferred Tax asset $1,200 (10,000 – 6,000) = 4000* 0.30 Dr. Deferred tax expense 1,200 Cr. Deferred Tax Assets 1,200 5. Prepare partial Income statement for the three years 2020 2021 2022 4

Income before tax 200,000 200,00 200,000 Less: income tax expense Current income tax Deferred tax exp/Benefit 63,600 (3600) 60,000 59,100 2400 61,500 60,300 1,200 61,500 Net income 140,000 138,500 138,500 Question 2 • Nilson Inc. had accounting income of $156,000 in 2020. 5

• Included in the calculation of that amount is the CEO's life insurance expense of $5,000, which is not deductible for tax purposes. • In addition, the undepreciated capital cost (UCC) for tax purposes is $14,000 lower than the net carrying amount of the property, plant, and equipment, although the amounts were equal at the beginning of the year. Required: Prepare Nilson's journal entry to record 2020 taxes, assuming IFRS and a tax rate of 25%. Accounting income 156,000 Adj: Permanent Diff 5,000 Temporary Diff (14,000) Taxable income 147,000 Dr. Current income tax expense 36,750 (147000 *0.25) Cr. Income tax payable 36,750 3) Dep. diff. is negative, so in future (when reversed, it will be +, also increases the income). o it is deferred tax liability. Dr. Deferred tax expense 36,750 Cr. Deferred Tax liability 36,750 Question 3 6

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The accounting records of Steven Corp., a real estate developer, indicated income before income tax of $850,000 for its year ended December 31, 2020, and of $525,000 for the year ended December 31, 2021. The following data are also available. 1. Steven Corp. pays an annual life insurance premium of $11,000 covering the top management team. The company is the named beneficiary. 2. The carrying amount of the company's property, plant, and equipment at January 1, 2020, was $1,256,000, and the UCC at that date was $960,000. Steven recorded depreciation expense of $175,000 and $180,000 in 2020 and 2021, respectively. CCA for tax purposes was $192,000 and $153,600 for 2020 and 2021, respectively. There were no asset additions or disposals over the two-year period. 3. Steven deducted $211,000 as a restructuring charge in determining income for 2019.  At December 31, 2019, an accrued liability of $199,500 remained outstanding relative to the restructuring, which was expected to be completed in the next fiscal year.  This expense is deductible for tax purposes, but only as the actual costs are incurred and paid for. The actual restructuring of operations took place in 2020 and 2021, with the liability reduced to $68,000 at the end of 2020 and to $0 at the end of 2021. 4. In 2020, property held for development was sold and a profit of $52,000 was recognized in income. Because the sale was made with delayed payment terms, the profit is taxable only as Steven receives payments from the purchaser. A 10% down payment was received in 2020, with the remaining 90% expected in equal amounts over the following three years. 5. Non-taxable dividends of $3,250 in 2020 and of $3,500 in 2021 were received from taxable Canadian corporations. 6. In addition to the income before income tax identified above, Steven reported a before- tax gain on discontinued operations of $18,800 in 2020. 7. A 30% rate of tax has been in effect since 2018. Steven Corp. follows IFRS. 7

Instructions a. Determine 2020 and 2021 taxable income and current tax expense. 2020 2021 Income before taxes 850,000 525,000 Insurance Expense Permanent difference 11,000 11,000 Depreciation Expense Temporary difference Deferred tax liability (17,000) Origin 26,400 Reverse Restructure Charge Temporary difference Differed tax asset (131,500) Reverse (68,000) Reverse Profit Temporary difference Deferred tax liability (46,800) Origin 15,600 Reverse Taxable dividends Permanent difference (3,250) (3,500) Taxable income from continuing operation 662,450 506,500 Discontinued operations 18,800 2) The carrying amount of the company's property, plant, and equipment at January 1, 2020, was $1,256,000, and the UCC at that date was $960,000. Steven recorded depreciation expense of $175,000 and $180,000 in 2020 and 2021, respectively. CCA for tax purposes was $192,000 and $153,600 for 2020 and 2021, respectively. There were no asset additions or disposals over the two-year period. 2020 2021 Company 175,000 180,000 8

CRA 192,000  origin 153,600  Reverse Adj: 17,000 26,400 Since CRA is charging higher depreciation, we can assume that there might be some equipment, which are new and are being depreciated at higher rate. Reverse might be higher than origin, might be because the reverse from other depreciation expense that was originated before 2020. 3) Steven deducted $211,000 as a restructuring charge in determining income for 2019.  At December 31, 2019, an accrued liability of $199,500 remained outstanding relative to the restructuring, which was expected to be completed in the next fiscal year.  This expense is deductible for tax purposes, but only as the actual costs are incurred and paid for. The actual restructuring of operations took place in 2020 and 2021, with the liability reduced to $68,000 at the end of 2020 and to $0 at the end of 2021. 2019 2020 2021 Expense 199,500 (131,500) (68,000) CRA not expense, (199,500 – 68000) 0 Not cash paid 199,500 4) In 2020, property held for development was sold and a profit of $52,000 was recognized in income. Because the sale was made with delayed payment terms, the profit is taxable only as Steven receives payments from the purchaser. A 10% down payment was received in 2020, with the remaining 90% expected in equal amounts over the following three years. 90% isn’t revenue yet ( 90% * 52,000) = 46,800 46800 / 3 = 15,600 5) Non-taxable dividends of $3,250 in 2020 and of $3,500 in 2021 were received from taxable Canadian corporations. This is a permanent difference, and always non-taxable 6) In addition to the income before income tax identified above, Steven reported a before-tax gain on discontinued operations of $18,800 in 2020. Discontinued operations must be mentioned in separate line, and taxes must be paid 9

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b. Prepare the journal entries to record current and deferred tax expense for 2020 and 2021. 2020 Dr. Current income tax exp. – Continuing operations $198,735 (662,450*0.30) Dr. Current income tax exp. – Discont. Operation $5,640 (18,800 *0.30) Cr. Income tax payable $204,375 Allowed to net the origin, if it originated in same period 2020 Dr. Deferred tax expense $19,140 Cr. Deferred tax liability $19,140 (17000 + 46,800 *30%) Dec. Deferred tax asset Dr. Deferred tax expense 39,450 Cr. Deferred tax asset 39,450 (131,500 *30%) 2021 Dr. Current income tax exp. 151,950 (506,000 *30%) Cr. Income tax exp. 151,950 1) Entry to reverse combined def. tax liability Dr. deferred tax liability 12,600 ( 26,400 +15,600 *30%) Cr. Deferred tax benefits 12,600 2) Reverse deferred tax asset Dr. Deferred tax exp Cr. Deferred tax asset 20,400 ( 68,000 *30%) Question 4 • Assume that on December 30, 2020, a new income tax rate is enacted that lowers the corporate rate from 30% to 25%, effective January 1, 2022. • If Rostel Corp. has one temporary difference at the beginning of 2020 related to $3 million of excess capital cost allowance, then it would have had a Deferred Tax Liability account at January 1, 2020 10

• Assume that the taxable amounts related to this difference are scheduled to increase its taxable income equally in 2021, 2022, and 2023. • Deferred tax rate 2020 3M 2021 1M 2022 1M 2023 1M origin 30% 25% 25% Because in 2020, company was not aware of new tax rate. It used 30% (old) rate to record deferred tax. Dr. Deferred tax exp. 900,000 Cr. Deferred tax liability 900,000 (3 million *30%) 2021  once they are aware of new rate, adj. entry needed. Deferred tax should equal to 1,000,000 * 30% + 1,000,000 * 25% + 1,000,000 * 25% = = 800,000 2021 2022 2023 Dr. Deferred tax liability 100,000 Cr. Deferred tax benefit 100,000 Question 5 • Powell Corporation has a taxable temporary difference related to net book value versus UCC of $715,000 at December 31, 2020. • This difference will reverse as follows: 2021, $53,000; 2022, $310,000; and 2023, $352,000. • Taxable Income in 2020 is $300,000 11 If the new rate is known, start using it ASAP.

• Enacted tax rates are as follow 2020 2021 2022 2023 25% 25% 30% 35% Record the tax expense current and deferred in 2020 • This difference will reverse as follows: 2021, $53,000; 2022, $310,000; and 2023, $352,000. • Taxable Income in 2020 is $300,000 • Enacted tax rates are as follow 2020 2021 2022 2023 25% 25% 30% 35% 1) To record current tax  current rate Dr. Current income tax expense 75,000 ( 300,000 * 25%) Cr. Income tax payable 75,000 2) To record deferred tax  Future rate Dr. Deferred tax expense $229,450 Cr. Deferred tax liability $229,450 (53,000 * 25% + 310,000 * 30% + 352,000 + 35%) Question 6 -Part 1 Tax Loss Carry back 12

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A company has taxable income for each year from 2017 to 2020. Assume there are no temporary or permanent differences in any of the years included. In 2021, the company incurred a tax loss they decided to carryback Required: a. Prepare the journal entry that Groh should prepare in 2021 regarding the loss carry back. We start from the oldest of the last 3 yrs. Is eligible to refund 2018, 2019, 2020, tax paid Why ? Loss is greater than taxable income in 3 years Total refund = 12,500 + 30,000 + 40,000 = $ 82,500 Dr. Income Tax receivable 82,500 Cr. Income tax benefit 82,500 b. How should the loss carry back be reflected on company’s financial statements at Dec.31,2021? Income before tax (500,000) Less: Tax benefit (82,500) Net Loss (417,500) Loss carry forward  It is recorded as “Deferred tax asset”  IFRS & ASPE agreed on recording deferred tax asset in the year of loss if the company is most likely will have profit next year  IFRS  no entry to record deferred tax assets ( loss carry forward) in the year of loss if the company don’t expect profit just o Just disclose in Notes 13

 ASPE  require an entry to record deferred tax asset (carry forward) if company don’t expect future profitability use valuation allowance method. Part 2 Assume that the company decided to carry forward the rest of 2021 loss. Also, it is probable they will generate sufficient taxable income in the future to absorb the loss. The future tax rate is 20%. Required: 14

a. Record the required journal entry for carry forward in 2021 IFRS and ASPE will record loss carry forward as “deferred tax asset” Dr. Deferred tax assets 30,000 (150,000 * 20%) Cr. Deferred tax benefit 30,000 b. How would the loss carry forward be reflected on Company's financial statements at Dec.31,2021? Net loss (500,000) Less: Tax Benefit 82,500 Current benefit – Loss carry back Deferred Tax benefit - Loss Carry forward Part 3 Assume that in 2022 the company returns to profitability and has taxable income of $200,000 subject to a 20% tax rate. Required: a. Record the journal entry record income taxes for 2022 Current income tax = 200,000 * 20% = $40,000 Less: Carry forward Benefit (30,000) 10,000 Dr. Current income tax exp. 10,000 Cr. Income tax payable 10,000 b. How would the realization of the loss carry forward be reflected on company's 2022 financial statements? Consider both IFRS and ASPE Decrease deferred tax credit 15

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Dr. Deferred tax expense 30,000 Cr. Deferred tax asset 30,000 c. How would your response change if company's taxable income had been less than $150,000? Current income tax < 30,000 benefit Assume that Current income 20,000 Less: Carry forward (20,000) 0 Part 4  Assume now that the company's future profitability is uncertain and that at December 31, 2021, there is not enough evidence that there will be future taxable income to deduct these losses against.  The company is applying IFRS. Required: a. Discuss the amount of deferred tax benefit that company should record. Only will disclose deferred tax asset in the notes, no entry is required to record loss carry forward. b. Prepare the tax-related journal entry(ies) assuming that the tax rate for future years will be 20% per year. Only loss carry back will be recorded Dr. Income tax receivable 82,500 Cr. Income tax benefit 82,500 + disclose of carry forward Part 5 Assume it is unlikely the benefit from the $150,000 loss carryforward will be realized in the future. The tax rate is 20%. Record the required entries assuming the company is following ASPE 16 Remember 10,000 carry forward will be calculable for the next year.

Dr. Deferred tax assets 30,000 (150,000 * 20%) CR. Deferred tax benefit 30,000 Dr. Deferred tax expense 30,000 Cr. Allowance to decrease depended 30,000 Tax asset to expected NRV Question 7 • Assume that Jensen Corp. has loss carry forward of $1 million at the end of its first year of operations. • Its tax rate is 20% • It is more likely than not that enough taxable income will be generated in the future 17

Required: a. Prepare the journal entry to record the deferred tax benefit and the change in the deferred tax asset. Dr. Deferred tax asset 200,000 (1,000,000 * 20%) Cr. Deferred tax benefit 200,000 b. Assume that at the end of its second year of operations, loss carryforward remains at $1 million but now only $750,000 meets the criterion for recognition. What journal entry should be recorded by the company? Compare IFRS with ASPE IFRS ASPE Directly decreae your asset in my book, deferred tax asset = 200,000 Now it become 750,000 * 20% = 150,000 Therefore, decrease deferred tax asset by $50,000 Dr. Deferred tax exp. 50,000 Cr. Deferred tax asset 50,000 Use valuation allowance Dr. Deferred tax exp. 50,000 Cr. Allowance to decrease depended Tax asset to expected NRV 50,000 c.How would the Deferred Tax Asset and related accounts be reflected on Jensen's SFP? Compare IRS and ASPE IFRS ASPE Deferred tax asset 150,000 Deferred tax assets 200,000 Allowance ( 50,000) Sullivan travels began operations in 2018 Total Loss 1,8600,000 2018 – taxable income 1,500,000 refund $675,000 Remaining loss 1,800,000 – 1,500,000 = 360,000 18

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2019 Refund = 360,000 * 40% = 144,000 Total tax benefit = 2018 refund + 2019 refund = 675,000 + 144,000 = 819,000 Prerax financial income for 2020 900,000 Tax exempt dividend -75000 Originianating temporary differenc Dr. deferred tax expense Cr. Lessee (Delaney) and lessor ( Maloney) X – man corp. Useful like become asset will be transferred to lessee after the lease BONDs  The 12% bonds payable of Tegan industries has a carrying amount of 3,120,000 on dec 31, 2019  The bonds, which had a face value of 3,000,000 were issued at a premium to yield 10%.  Tegan uses the effective method 2 nd bond question Gain = Price paid - CV at repurchase time Price paid= 2,000,000 *96% = 1,920,000 CV at repurchase time = issuane price ( 9,000,000 * 103) 9.270,000 Less: Amortizated premium ( premium 9,270,000 – 9,000,000 * 7/100) (189,000) 9,081,000 CV CV of repurchased bonds = 1, 91,2000 < CV 2,018,000 Gain = 98,000 19